Journal of International Management 10 (2004) 479 500

The competitive advantage and strategic configuration of knowledge-intensive, small- and medium-sized multinationals: a modified resource-based view
Tamar Almora,*, Niron Hashaia,b,1
School of Business Administration, College of Management-Academic Studies, 7 Yitzhak Rabin Blvd., P.O. Box 9017, Rishon LeZion 75910, Israel b Jerusalem School of Business Administration, The Hebrew University, Mount Scopus, Jerusalem 91905, Israel Available online 25 September 2004
a

Abstract This study employs a modified resource-based approach to examine the competitive advantage enjoyed by knowledge-intensive, small- and medium-sized multinationals (KI-SMMs). While the resource-based view addresses superior capabilities only, this paper examines both superior and inferior capabilities and their resulting sustainable competitive advantage. Compared to larger knowledge-intensive multinationals, KI-SMMs possess more inferior than superior core capabilities. Despite this handicap, the paper demonstrates how KI-SMMs compete globally by leveraging their relatively superior R&D capabilities and by choosing a strategic configuration that allows them to compete internationally despite their relatively inferior capabilities in marketing and production activities. Our results show that KI-SMMs internalize R&D activities, which are their core capabilities, externalize production activities, in this case noncore capabilities, and internalize marketing activities, for which they have an inferior capacity, but which are, arguably, core capabilities. KISMMs compensate for their inferior capabilities in marketing activities through the use of a unique

* Corresponding author. Tel.: +972 3 9634270; fax: +972 3 9634117. E-mail addresses: talmor@colman.ac.il (T. Almor)8 nironH@huji.ac.il (N. Hashai). 1 Tel.: +972 2 5883110; fax: +972 2 5881341. 1075-4253/$ - see front matter D 2004 Elsevier Inc. All rights reserved. doi:10.1016/j.intman.2004.08.002

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business model which focuses repeat sales to customers with whom a low number of high-value transactions can be maintained. D 2004 Elsevier Inc. All rights reserved.
Keywords: Small- and medium-sized multinationals; Knowledge-intensive firms; Resource-based view; Internalization; Internationalization

1. Introduction Small- and medium-sized enterprises (SMEs) have been playing a progressively important role in international business since the beginning of the last decade (Bell, 1995; Keeble et al., 1997; McNaughton, 2000; Oviatt and McDougall, 1994; Rugman and Wright, 1999). By the late 1990s, about a quarter of SMEs around the world derived a major portion of their revenues from foreign countries (Oviatt and McDougall, 1999). The explanations for the accelerated internationalization of SMEs are numerous and include entrepreneurial vision and capabilities, prior foreign experience of entrepreneurs (Oviatt and McDougall, 1994), emergence of global demands for goods and services that enables small firms to adopt an international perspective regardless of age and size (Oviatt and McDougall, 1997), the need to reach markets of sufficient size and exploit first-mover advantages (McNaughton, 2000), and the ability to rely on international networks and strategic alliances (Bell, 1995; Bonaccorsi, 1992; Coviello and Munro, 1997; GomesCasseres, 1997; Kaufmann, 1995). However, the international performance of these relatively small firms remains paradoxical, as it is difficult to explain how firms with limited financial resources and with little managerial experience (Buckley, 1989; Kaufmann, 1995; Lu and Beamish, 2001) are able to compete globally against larger and more experienced firms. It is therefore not surprising that most literature on the performance of firms in the international business arena relates to large, well-established multinational corporations (MNCs) that are perceived as firms that operate internationally because of their size and experience (e.g., Agarwal and Ramasawi, 1992; Buckley and Casson, 1976; Caves, 1971, 1996; Chandler, 1986, 1990). The current study contributes to the question of how relatively small firms create and sustain competitive advantages in the international business arena by focusing on the determinants of the competitive advantage held by small- and medium-sized, knowledgeintensive firms that have become multinationals. We label these firms: knowledgeintensive, small- and medium-sized multinationals (KI-SMMs). The concept of KI-SMMs2 has gained attention in recent years (e.g., Jones, 1999, 2001; Keeble et al., 1997; Knight and Cavusgil, 2004; Narula, 2002; Stray et al., 2001), most probably because it seems that many of the smaller multinationals have knowledge-based

2 Alternative popular terms to KI-SMMs are small high-technology firms, knowledge-based SMEs, small knowledge-intensive firms or small technology-based firms. An operational measure of the term KI-SMM is presented in the Data section.

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products. KI-SMMs cannot be classified as MNCs because of their comparatively small size and limited scope of operations nor can they be viewed as exporting SMEs (e.g., in Aaby and Slater, 1989; Bilkey and Tesar, 1977; Bonaccorsi, 1992; Cavusgil, 1984; Gemunden, 1991; Reid, 1982, 1984), because they use a variety of strategies to compete internationally in addition to exports, such as the establishment of greenfield subsidiaries, the use of international strategic alliances as well as mergers and acquisitions. Thus, these firms have unique characteristics that set them apart from MNCs on the one hand and from exporting SMEs on the other. Taking into account the high failure ratio for knowledge-intensive start-ups (Ruhnka et al., 1992; Timmons, 1999), KI-SMMs are assumed to be those SMEs that survived the fierce competition of the international marketplace and succeeded in creating and sustaining a competitive advantage. Moreover, while small- and medium-sized multinationals need not necessarily be knowledge-intensive, they are frequently characterized in the literature as firms that sell innovative, self-developed, technology-based products (Bell, 1995; Jones, 1999, 2001; Keeble et al., 1997; Oviatt and McDougall, 1994; Rugman and Wright, 1999; Stray et al., 2001). We assert that dsizeT and dknowledge intensityT are central attributes in explaining the strategic configuration chosen by these firms. As detailed below, by dstrategic configurationT we refer to decisions made by these firms regarding the internalization of their value activities as well as their selected business model. Conceptually, the strategic configuration of KI-SMMs can be compared to those of non-knowledge-intensive SMMs, larger knowledge-intensive MNCs, and larger nonknowledge-intensive MNCs. In the current study, we demonstrate how the strategic configuration of KI-SMMs differs from that of larger knowledge-intensive MNCs (KIMNCs). We use the resource-based view of the firm to explain how KI-SMMs create and sustain competitive advantage. In the next section, we present a modified version of the resource-based view which we subsequently employ to assess the capabilities of KI-SMMs compared to those of KIMNCs in terms of their performance of R&D, production, and marketing activities. Subsequently, our proposed framework is empirically tested on a sample of Israeli KISMMs. In the final section, our findings and their implications are discussed.

2. A modified resource-based view The resource-based view (RBV) of the firm has come to wield significant influence since the beginning of the 1990s (Connor, 2002; Medcof, 2000). Scholars adhering to the resource-based view (e.g., Barney, 1991; Peteraf, 1993; Wernerfelt, 1984) suggest that a firms competitive advantage may be best explained by the heterogeneity of firm-specific resources and their application, rather than by differences in industry characteristics. According to the RBV (Barney, 1991; Peteraf, 1993; Wernerfelt, 1984), a firm may be perceived as a set of interconnected tangible and intangible resources that create organizational capabilities. We refer to capabilities as the capacity to perform a particular function or value activity (Grant, 1998). This capacity is believed to be a positive function of the firms resources. Thus, if firm A possesses superior resources relative to firm B, and

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if firm B cannot access equivalent resources, then firm A is expected to have superior capabilities. Firms are particularly interested in having superior core capabilities, often referred to as dcore competenciesT (Prahalad and Hamel, 1990). Core capabilities are those that make a disproportionate contribution to ultimate customer value, or to the efficiency with which the value is delivered, and they provide a basis for entering new markets (Hamel and Prahalad, 1992). Superior core capabilities enable firm A to gain higher Ricardian rents than firm B (Peteraf, 1993). This in turn implies that firm A has a competitive advantage over firm B; that is, firm A is able to create a higher economic value for its customers. The RBV further proposes that sustainable competitive advantage (SCA) stems from having a set of unique resources that create value in the marketplace (Medcof, 2000). Sustainable competitive advantage is defined as the firms ability to outperform its competitors in the long run, i.e., when competitive advantage persists despite efforts to duplicate or neutralize it (Barney, 1991). Thus, firm A will be able to sustain its competitive advantage over firm B only if the resources that create superior core capabilities are durable and inimitable, being nontransparent, nontransferable or nonreplicable (Barney, 1991; Dollinger, 1999; Peteraf, 1993). Although the insights of the RBV are powerful in explaining how competitive advantage is created and sustained, one of the flaws of the RBV is that it overlooks the case where some of the firms core capabilities are superior compared to those of its competitors, while other core capabilities are comparatively inferior (e.g., when a firm has a technological advantage but lacks marketing experience). While the importance of minimizing organizational weaknesses and maximizing organizational strengths has been a part of strategic management literature for a quite long while (e.g., Andrews, 1971, pp. 90102), it was left out of mainstream RBV argumentations. Considering inferior capabilities and not only superior capabilities is particularly important for the analysis of a firms competitive advantage, because inferior core capabilities may neutralize the competitive advantage created by superior ones. Hence, we assert that in order to achieve a competitive advantage over firm B, the abovementioned firm A should not only maintain the positive gap it has over firm B in its superior core capabilities but also compensate for any relatively inferior core capabilities it has compared to firm B. However, this is by no means a trivial task. Firm A is likely to maintain the gap it has in its superior core capabilities as long as the resources that create these capabilities remain durable and inimitable. However, how can firm A close the gap and neutralize its disadvantage with respect to resources that produce inferior core capabilities? One way for firm A to close the gap with respect to inferior core capabilities is to reconfigure its resources so they create upgraded capabilities (Itami, 1987; Porter, 1991). While this view is consistent with the emergent literature on dynamic capabilities (Eisenhardt and Martin, 2000), the basic notions of the RBV imply that often this task is extremely difficult, requires tremendous resource investment over long periods of time, and is sometimes even impossible. Firm A can try to acquire the required core capabilities from firm B or from the market. However, capabilities that are available in the market are not likely to be particularly

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Chart 1. Core capabilities and their comparative position.

superior, because they are either already possessed or available for acquisition by other firms. Hence, the only option that allows firm A to compensate for inferior core capabilities is to choose a business model that minimizes the inferiority of its capabilities. For example, if firm A has an inferior technological capability compared to firm B, it may aim to target customers that are price-, rather than quality-sensitive. Alternatively, if firm A is disadvantaged in its capabilities to perform marketing activities, it may choose to license its product or, alternatively, focus on repeat sales to a small and limited customer base, rather than interacting with a large number of customers in an expanding customer base. Following the above discussion, the current study puts forth the argument that KISMMs create and sustain competitive advantage not only by maximizing the advantages that stem from their superior core capabilities, but also by compensating for the disadvantages arising from their having core capabilities in which their capacity is inferior to that of larger KI-MNCs. We pose that while inferior capabilities that are not core capabilities may be acquired in the market (i.e., via external organizations), inferiority in core capabilities cannot be neutralized through acquisitions. Instead, it might be compensated for by a business model that enables the firm to minimize the impact of its inferior capability. This view is depicted in Chart 1.

3. Assessing the capabilities of KI-SMMs The two dominant characteristics of KI-SMMs are their relatively small size and their knowledge intensity. The combination of these two characteristics is expected to have a substantial impact on the capabilities of these firms.

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For reasons of simplicity, we follow Buckley and Casson (1976), Jones (1999) and others and focus on assessing the capabilities of KI-SMMs to perform three major value activities: (1) R&Dcreation and development of knowledge and consumable technology; (2) productiontransforming inputs into outputs; (3) marketingwhich relates to the interaction between the firm and its customers during the processes of promotion, sales, distribution, and pre- and postsales services. Next, we analyze the capabilities of KISMMs to perform each of these value activities compared to KI-MNCs. 3.1. R&D Proprietary technology is a resource around which distinctive capabilities and the firms profit-earning potential are developed (Grant, 1998; Knight and Cavusgil, 2004). Technology-based firms will usually enjoy first-mover as well as monopolistic advantages, denoted by Wernerfelt (1984) as resource position barriers. Thus, unique know-how and proprietary technology are a significant resource upon which a competitive advantage can be created. Although this is true for both KI-SMMs and KI-MNCs, the relatively smaller size of the former implies that they are often much more flexible than the latter (Narula, 2002; Peng, 2001). This flexibility implies that, compared to larger KI-MNCs, KI-SMMs are able to make quicker decisions and to react faster to market needs, because their organizational structure is less bureaucratic than that of larger organizations. We therefore expect that KISMMs will be quicker to develop unique technologies, will be more innovative (Acs et al., 1997; Knight and Cavusgil, 2004; Lewin and Massini, 2003), will better focus on the specific technological needs of customers, and will be quicker in their response to these needs than KI-MNCs. Moreover, their small size usually encourages KI-SMMs toward innovation in specific areas that are likely to be less attractive to KI-MNCs. The latter may often wish to develop applications that are of interest to the mainstream market and neglect applications that have a limited market potential. This can create opportunities for KISMMs to introduce new and unique technologies in unexplored fields, which in turn may enable them to gain substantial first-mover advantages. This point of view is supported by numerous studies that assert that KI-SMMs have superior technological capabilities that drive them to international markets in order to exploit first-mover advantages and monopolistic gains (Acs et al., 1997; Amin and Thrift, 1994; Keeble et al., 1997; McNaughton, 2000). While, on the whole, KI-MNCs have more financial resources that enable them to sustain substantial R&D expenses; studies show that KI-SMMs frequently may have a superior capability to perform R&D activities in the sufficiently narrowly defined technological field in which it specializes (Buckley and Mirza, 1997; Knight and Cavusgil, 2004; Lewin and Massini, 2003; Manalova, 2003). 3.2. Production While the production processes for knowledge-intensive products vary considerably from one product to another, it is possible to classify them into three broad categories. The first category includes the production processes for intangible products, e.g., the reproduction of software. Such production processes involve transferring developed

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knowledge into a medium that is then distributed to customers (e.g., copying software onto a CD-ROM or e-mailing software to customers). The second category consists of products that are based on knowledge that is embedded in a larger system (for instance knowledge embedded in a chip that allows high-quality digital photography). The third category relates to products in which mass manufacturing of the product is required (e.g., mass production of microprocessors or drugs). In the first case, production is virtually nonexistent, or production skills are so common that no particular competitive advantage is expected to arise from engaging in production. The second and third categories require substantial economies of scale and/or production efficiency based on a superior position along the experience curve. While KI-SMMs may have a superior capability to conduct a particular proprietary part of the production process, on the whole, their capability to produce large systems or to engage in mass production is quite limited. Due to their small size, KI-SMMs have limited financial and managerial resources (Buckley, 1989; Kaufmann, 1995; Lu and Beamish, 2001), which hamper their capability to either exploit economies of scale or rapidly ride the experience curve. KI-MNCs are expected to be larger and more experienced and thus better positioned to exploit these advantages. We therefore conclude that KI-SMMs are expected to be inferior in their capabilities to perform production activities than KI-MNCs. 3.3. Marketing In order to exploit first-mover advantages and achieve monopolistic gains from superior technological capabilities, KI-SMMs are driven early to international markets (Amin and Thrift, 1994; Jones, 1999, 2001; Keeble et al., 1997; Knight and Cavusgil, 2004; McNaughton, 2000; Stray et al., 2001). The relatively small size of KI-SMMs becomes critical when we consider the need for international market dispersion. International market dispersion requires the ability to operate and control multiple and scattered operations and serve customers that are situated at a considerable distance from these firms home countries (Calof, 1993). When comparing them to KI-MNCs, KI-SMMs have relatively inferior capabilities in marketing activities because of the paucity of their resources. KI-MNCs have more resources and experience that enable them to establish and coordinate an internationally dispersed marketing infrastructure, to control a greater market share, to ride the learning curve faster, to enjoy a stronger bargaining power with customers, and to weather more mistakes without incurring failure (Agarwal and Ramasawi, 1992; Aharoni, 1966; Porter, 1985). While the above discussion mainly addresses size, we argue that inferior capabilities in marketing activities have a greater impact on knowledge-intensive firms than on nonknowledge-intensive ones. Knowledge-intensive firms need to interact more frequently with their customers than non-knowledge-intensive firms. This interaction is vital for knowledge-intensive firms, because their products are frequently unknown, new, and based on proprietary knowledge. Interaction with clients facilitates the provision of firmspecific services (Hirsch, 1989), which may include creating awareness of the product, demonstrating its attributes, and, when necessary, dtailoringT the product to specific customer requirements, as well as providing training, installation, running-in, main-

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tenance, and repairs on the product. Most of these activities are directly related to the proprietary knowledge base of these firms (Hirsch, 1989; Almor and Hirsch, 1995). The fact that knowledge-intensive firms have more frequent interactions with their customers implies that KI-MNCs greater marketing resources place them at an advantage vis-a-vis KI-SMMs. We therefore conclude that the capabilities of KI-SMMs to perform ` marketing activities are expected to be inferior to those of KI-MNCs. The above discussion raises the question: how do KI-SMMs compensate for their inferior capabilities in production and marketing and compete globally with KI-MNCs? We propose that the answer to this question lies in their choice of strategic configuration. By strategic configuration, we refer to the firms decisions regarding (i) whether to externalize or internalize each value activity, and (ii) the appropriate business model.

4. The strategic configuration of KI-SMMs Chart 2 outlines our expectations regarding the strategic configuration of KI-SMMs. As detailed below, we pose that size and knowledge-intensity of the products are the major triggers that stimulate KI-SMMs to pursue this particular strategic configuration in order to create and sustain competitive advantage. Because ownership of technology is one of the most important bases for the development of competitive advantage, KI-SMMs are expected to exploit their superior capabilities in R&D activities to create a competitive advantage around their unique knowhow and proprietary technology (Amin and Thrift, 1994; Jones, 1999, 2001; Keeble et al., 1997; McNaughton, 2000; Stray et al., 2001). The need to control R&D resources by developing them internally stems from the desire of KI-SMMs to make these resources durable and inimitable. R&D activities lead to technological developments that create value to customers. Hence, the capability to perform R&D activities is expected to be a core capability of KI-SMMs and thus become a major determinant of their competitive advantage. Internalization of R&D will enable KI-SMMs to keep technological knowledge proprietary and thus secure the sustainability of their competitive advantage (Tallman, 1991). This is consistent with the major contention of transaction cost theory regarding internalization of R&D activities (Pisano, 1990), as well as with Madhoks (1997) view on the positive link between internalization and organizational capabilities. We therefore expect that R&D will be performed in-house (i.e., internalized), so that firms capabilities remain hard to copy and rare for as long as possible. We further expect that the performance of KI-SMMs will be positively correlated to their R&D expenses (Qian,

Chart 2. Strategic configuration as a determinant of KI-SMMs competitive advantage.

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2002), indicating that when R&D activities are internalized, relatively more financial resources are diverted towards them. Our previous discussion led us to the conclusion that production is not a dcoreT capability for KI-SMMs. Moreover, because of relatively inferior production capabilities, it is expected that strategic alliances (e.g., outsourcing) may be preferred over in-house production, because it would enable access to complementary assets (Teece, 1986). Thus, we expect production to be externalized as long as proprietary know-how is protected (e.g., by patents). In order to protect firm-specific proprietary know-how, KI-SMMs may choose to produce the components in which proprietary know-how is embedded while using collaborations to manufacture standard components, which make a minor contribution to value creation for customers. Following the same logic, KI-SMMs are also expected to pursue strategic alliances in order to compensate for their inferior capabilities in marketing activities. However, we argue that this is not the case. As noted earlier, KI-SMMs are expected to interact frequently with their customers in the process of providing pre- and postsale services. The nature of these interactions (as described above) implies that marketing activities are expected to make a major contribution to the process of creating customer value. Hence, marketing activities, unlike production, are expected to be a core capability of KI-SMMs. Tight suppliercustomer relations allow firms to protect their proprietary know-how, to receive feedback regarding their technology through the processes of distribution, and after-sales services and may lead to further technological innovations, customer loyalty, and a strong client base (Almor and Hirsch, 1995; Hirsch, 1989). These interactions require unique skills and specific expertise in the processes of promotion, sales, distribution, and postsale services and therefore are likely to be better performed by skilled employees who receive ongoing training from the firm, rather than by external organizations. Therefore, we expect that KI-SMMs will perform marketing activities inhouse in order to maximize the benefit they gain from customer-related technological spillovers and to prevent potential diffusion of propriety technological and marketing know-how to partners in the process of joint operation (Anderson and Gatignon, 1986; Agarwal and Ramasawi, 1992; Root, 1994; Simonin, 1999). This argument is consistent with the vast literature on marketing channels integration (Aulakh and Kotabe, 1997; Heide, 1994; Heide and John, 1998; Klein et al., 1990; Madhok, 1997). We further expect successful KI-SMMs to incur high distribution and after-sales services expenses, because they need to interact frequently with their customers, who are dispersed internationally. Thus, we expect that the performance of KI-SMMs will be positively correlated with their marketing expenses. The above discussion leads us to the following hypotheses: Hypothesis 1. The propensity of KI-SMMs to internalize R&D and marketing activities is higher than their propensity to internalize production activities. Hypothesis 2. The performance of KI-SMMs is positively correlated with their R&D and marketing expenses. As a result of the limited size of KI-SMMs, it is quite complicated to serve multiple foreign markets through internal marketing entities, because the collection, transmission,

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and interpretation of market information are very costly and time consuming (Carson and Gilmore, 2000). Operation of multiple marketing entities becomes nearly impossible when considering that managerial skills, international experience, human resources, and finance are all expected to be scarce resources for KI-SMMs. The solution to this dilemma lies in the choice of a business model. Let M denote the potential market size of a specific product, and T denote the average transaction value in this market. The potential number of transactions (N) that a KI-SMM faces can then be denoted by: N=M/T. We pose that due to their resource constraints, KISMMs will aim to minimize the number of transactions (N) they execute, thereby forgoing the need for extensive marketing operations. This can be achieved in two ways. One option is to limit their market size (M) by targeting a specific market niche that consists of a few customers worldwide (Gomes-Casseres, 1997; Kohn, 1997; McNaughton, 2000). This concept of deep-niche strategies is well established in the literature. A second option is to increase the value per transaction (T) by targeting a few large, organizational customers. Such organizational customers may be end customers, OEM clients, resellers, or value added representatives (VARs). While such organizational customers may represent the mainstream market, the number of transactions with these customers is expected to be fairly low. When serving organizational customers and specific market niches, the absolute number of customers is much smaller than when mass-market consumers are targeted. The need for a substantial marketing infrastructure is reduced, and a modest marketing entity may suffice. Thus, a KI-SMM is expected to internalize its marketing activities, but to choose a business model which allows focusing on a few transactions that provide maximum value per transaction. We therefore hypothesize that Hypothesis 3. The propensity of KI-SMMs to perform marketing activities in-house is positively correlated with their choice to serve organizational customers and market niches. Returning to Chart 1, we conclude that KI-SMMs are expected to have superior capabilities in performing R&D activities; these capabilities contribute heavily to customer value creation and thus are considered to be core capabilities (Quadrant I). Superiority in R&D is preserved and strengthened by internalization. The capabilities of KI-SMMs in performing production activities are inferior to those of KI-MNCs, are of minor importance to customer value creation, and thus are considered to be noncore capabilities (Quadrant IV). It follows that production activities may be externalized. Finally, whereas KI-SMMs are inferior in their capabilities to perform marketing activities, these capabilities are extremely important to customer value creation and hence are considered to be core capabilities (Quadrant II). KI-SMMs may endanger their competitive position if they externalize these activities, therefore, they internalize them and compensate for their inferiority by targeting customers with whom a low number of high value transactions can be maintained.

5. Data The sample was taken from a population of Israeli firms which were traded during the year 2000 on non-Israeli stock exchanges. By focusing on this population, we were

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able to examine firms with a proven track record of business activity. We regarded the ability of such firms to go through an Initial Public Offering (IPO) outside Israel as an indicator that they (1) passed successfully through the initial growth phases, (2) possessed some sort of competitive advantage, and (3) had a strong international orientation. Firms were included in the research sample when they answered to all three criteria below: 1. Knowledge-intensity. We chose firms that operated in industries defined as technology-based by the Central Bureau of Statistics (2003). These include the software, information and communication technology, electronics, pharmaceutical, biotechnology, and medical technology industries. Size. Because we focused on KI-SMMs, we decided to limit the sample to firms that enroll less than 1% of the average number of employees found in the worlds 100 largest MNCs (UNCTAD, 2001). Thus, the largest KI-SMM in our sample employed about 1000 employees. Multinationality. We only included firms that owned at least one foreign subsidiary (Fujita, 1995).

2.

3.

The above criteria were intended to ensure that our sample would contain firms that are knowledge-intensive and are small- to medium-sized compared to large MNCs. Initially, 140 Israeli industrial firms that are traded outside Israel were identified. Firms that, during the year 1999, did not belong to the aforementioned technology-based industries, did not own a foreign subsidiary, or employed over a thousand employees were excluded from this list. The senior management of the remaining 75 firms was approached and asked to take part in a face-to-face interview. In-depth interviews with CEOs or VPs took between 60 and 120 min and were conducted as focused interviews. They were based on semistructured questionnaires that were used to elicit the views of the interviewee, untainted by the interviewers preconceptions to the extent possible. The questionnaire included 50 questions and covered a wide range of topics, including general information, internationalization, the value added chain, innovation, alliances, competition, strategic characteristics, and financial data. The relevant questions for the purpose of the current study are presented in Appendix A. The response rate was 69% (52 firms). Basic comparisons between the 52 participating firms and the 23 nonparticipating firms did not show evidence of any response bias in terms of firm sales, number of employees, age, industrial classification, and percentage of international sales. Descriptive statistics presented in Table 1 show that the firms in our sample are fairly young and small- to medium-sized (both in terms of sales and number of employees). These firms have a strong international orientation: most of their revenues are generated from multiple international markets rather than from the Israeli market. The firms in the sample may be characterized as knowledge-intensive both in terms of the ratio of R&D expenses to sales and the percentage of products that were developed in-house during the 3 years prior to our study.

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Table 1 Descriptive statistics of Israeli KI-SMMs (for the year 1999) Variable Year of establishment Sales ($, M) Number of employees Percentage of sales in Israel Number of foreign markets Ratio of R&D expenses to sales (percentage) Percentage of products developed in-house within the last 3 years Average 1989 46 274 11 32 25 54 Range 19771996 0338 151020 060 186 5246 0100

Because we focused on KI-SMMs with a proven track record of business activity, the firms in our sample are similar in size to those studied by Gomes-Casseres (1997), Knight (2001), and Knight and Cavusgil (2004), and somewhat larger than the SMEs that have been examined in other studies (e.g., Coviello and Munro, 1997; Keeble et al., 1997; McNaughton, 2000).

6. Findings Preliminary to testing the hypotheses, we examined whether the perceptions of the firms in our sample regarding their own strategic capabilities fit our expectations. During the interview, firms were requested to rank their strategic capabilities (see details in Appendix A). Results (as presented in Table 2) show that capabilities in R&D (e.g., innovation, understanding technological needs) are ranked much higher than in production (e.g., high production quality, low cost resources) and in marketing (marketing and aftersale services). Based on this preliminary conformation of our expectations regarding the capabilities of KI-SMMs, we went on to test our formal hypotheses. The first hypothesis stated that the propensity of KI-SMMs to perform R&D and marketing activities in-house is higher than the propensity to perform production activities in-house. Every firm in our sample was asked to report if it was conducting its R&D, production, and marketing activities exclusively in-house or not (see Appendix A). We then used the CochranMantelHaenszel (CMH) statistic to test the hypothesis. The CMH statistic is a nonparametric measure that serves for testing hypotheses regarding the
Table 2 Self-reported strategic capabilities Strategic capability Innovation Time to market Understanding technological needs of clients Marketing and after sales services High production quality Low cost resources Other
a

Total rankinga 71.9 50.1 76.7 10.7 25.7 3.6 13.2

Summation of the rankings as detailed in Appendix A.

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equality of two matched distributions, measured on a categorical (nominal) scale. In this study, the CMH statistic was used to compare chi-square tests on binary variables. Of the firms in our sample, 80% performed their R&D activities exclusively in-house and 72% performed marketing activities exclusively in-house, whereas only 28% performed production activities exclusively in-house. The CMH statistic indicates that a significant difference exists between the propensity of KI-SMMs to internalize R&D and marketing activities and their propensity to internalize production (v 2=15.70, df=1, pb0.0001), thus supporting Hypothesis 1. Hypothesis 2 posed that the performance of KI-SMMs is positively correlated to their R&D and marketing expenses. We tested this hypothesis by means of Ordinary Least Squares (OLS) regressions. We used two common profitability ratios (Grant, 1998) as proxies for KI-SMMs performance: (i) the ratio of operating profit to sales (denoted as Model 1); (ii) the ratio of operating profit to firm assets (denoted as Model 2). In order to ensure a normal distribution of both dependent variables ( y i ), they were transformed into an exponential form (e yi ). The normal distribution of e yi was confirmed by the Shapiro Wilk test. The explanatory variables included (1) the ratio of R&D expenses to sales (in 1999) and (2) the ratio of marketing expenses to sales (in 1999). These variables are calculated as R&D and marketing expenses, respectively, normalized by sales volume. These ratios are often used to represent firms outlays on R&D and marketing activities relative to their size (e.g., Almor and Hirsch, 1995; Jones, 1999; Lindell and Karagozolu, 1997; Trevino and Gross, 2002). Firms that internalize these activities are expected to incur relatively higher ratios than those that externalize such activities. We also included the following control variables: (1) firm size (measured by number of employees)in order to control for possible size effects; (2) firm agein order to control for possible age effects; (3) the ratio of the cost of goods to salesin order to control for product characteristics and operational efficiency effects; (4) industryin order to control for industry effects on profitability; and (5) location of R&D, production, and marketing activities (exclusively in Israel or also abroad)in order to control for possible cost effects that result from the internationalization of value activities (see detailed measures in Appendix A). We used backward stepwise OLS regression in order to identify the best regression model for the dependent variables. Tables 3 and 4 detail the explanatory models in terms of the coefficients of the variables that turned out significant, the adjusted R 2 values and the values of the F statistic (ANOVA). In Appendix B, the Pearson correlations between the continuous significant variables (i.e., those which are not binary) are presented. Because Appendix B indicates that a correlation exists between the variables, we decided to verify that no multicollinearity exists between the independent variables and for lack of hetroskedasticity. Multicollinearity was excluded because the last two columns in Tables 3 and 4 indicate that the tolerance statistic (which is calculated as 1 minus R 2 for an independent variable when it is predicted by the other independent variables already included in the analysis) was not too low (i.e., tolerance values below 0.2 usually indicate a suspicion for multicollinearity), and subsequently that the Variance Inflation Factor (VIF) values (which represent the reciprocal of the tolerance) were not too large. In addition, a collinearity diagnostics analysis indicated that the condition indices for all independent variables were

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Table 3 Performance of KI-SMMs and their expenditure on R&D and marketing activities: ratio of operating profit to sales Dependent variable Independent variables Constant Ratio of R&D expenses to sales Ratio of marketing expenses to sales Number of Employees Firm age Ratio of cost of sales to sales Industry 1 (telecommunication) Industry 2 (electronics) Industry 3 (software) Industry 4 (otherpharmaceutics, biotechnology, medical technologies) Location of R&D (exclusively in Israel/in host markets) Location of production (exclusively in Israel/in host markets) Location of marketing (exclusively in Israel/in host markets) Adjusted R 2 ANOVA ( F value) N n.s.Not significant, n.a.not available. * Significant at pb0.1. ** Significant at pb0.01. *** Significant at pb0.001. Model 1 operating profit/sales Coefficients 0.724** 2.526*** 1.804*** n.s. n.s. 2.143*** n.s. 0.338* n.s. n.s. n.s. n.s. n.s. 0.752 27.48 35 Collinearity statistics Tolerance 0.556 0.491 n.a. n.a. 0.588 n.a. 0.677 n.a. n.a. n.a. n.a. n.a. VIF 1.799 2.037 n.a. n.a. 1.791 n.a. 1.477 n.a. n.a. n.a. n.a. n.a.

lower than 9 (where 15 is the minimal value to indicate a possible multicollinearity problem). Hetroskedasticity was excluded because the plots of the residuals against the dependent variables showed a random distribution of the residuals. This was further verified by running regressions of the residuals against the dependent variables. As expected, these regressions turned out to be insignificant, indicating that the residuals did not contribute an additional explanation to the dependent variables. The data in Tables 3 and 4 indicate a significant positive correlation between the ratio of marketing expenses to sales and firm profitability. The ratio of R&D expenses to sales was significant only in model 1. Because both regression models have fairly high adjusted R 2 values, we conclude that Hypothesis 2 is mostly supported. Hypothesis 3 poses an expected positive correlation between the internalization of marketing activities and the nature of the firms customers, in terms of serving organizational customers and market niches. We employed a binary logistic regression model to test this hypothesis, where the dependent variable indicated whether a firm internalizes marketing activities (i.e., performs them exclusively in-house) or not. In addition, each firm was asked to report whether it primarily targeted market niches (rather than the mainstream market) and whether the majority of its customers were organizational (i.e., either OEM, end customers that are organizations, or resellers). The following control

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Table 4 Performance of KI-SMMs and their expenditure on R&D and marketing activities: ratio of operating profit to assets Dependent variable Independent variables Constant Ratio of R&D expenses to sales Ratio of marketing expenses to sales Number of Employees Firm age Ratio of cost of sales to sales Industry 1 (telecommunication) Industry 2 (electronics) Industry 3 (software) Industry 4 (otherpharmaceutics, biotechnology, medical technologies) Location of R&D (exclusively in Israel/in host markets) Location of production (exclusively in Israel/in host markets) Location of marketing (exclusively in Israel/in host markets) Adjusted R 2 ANOVA ( F value) N n.s.Not significant, n.a.not available. ** Significant at pb0.01. *** Significant at pb0.001. 1.350*** n.s. 0.671*** n.s. n.s. 0.686*** n.s. n.s. n.s. n.s. 0.127** n.s. n.s. 0.626 20.01 34 Model 2 operating profit/Assets Collinearity statistics Tolerance n.a. 0.738 n.a. n.a. 0.748 n.a. n.a. n.a. n.a. 0.958 n.a. n.a. VIF n.a. 1.534 n.a. n.a. 1.337 n.a. n.a. n.a. n.a. 1.044 n.a. n.a.

variables were used: (1) firm size (measured by number of employees)in order to control for possible size effects; (2) firm agein order to control for possible age effects; and (3) industryin order to control for industry effects (see detailed measures in Appendix A).
Table 5 Internalization of marketing activities: results of a binary logistic regression model Dependent variable Independent variables Constant Serving market niches (yes/no) Serving organizational customers (yes/no) Number of Employees Firm age Industry 1 (telecommunication) Industry 2 (electronics) Industry 3 (software) Industry 4 (otherpharmaceutics, biotechnology, medical technologies) Cox and Snell R 2 Nagelkerke R 2 n.s.Not significant. * Significant at pb0.05. Internalization of marketing Coefficient 34.664* 12.242* 11.277* n.s. n.s. n.s. n.s. n.s. n.s. 0.474 0.691

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We used a backward stepwise regression procedure to test the validity of the regression model, the results of which appear in Table 5. Table 5 indicates that targeting market niches and organizational customers are both significant explanatory variables for conducting marketing activities exclusively in-house. The values of the Cox and Snell R 2 and Nagelkerke R 2 (which are the equivalent of an adjusted R 2 in binary logistic regressions) were also fairly high. Hypothesis 3 is therefore confirmed.

7. Discussion and conclusions In this study, we asserted that KI-SMMs create and sustain their competitive advantage not only by securing and protecting superior capabilities but also by compensating for inferior ones. This approach is different from the standard interpretation of the resourcebased view that relates only to superior capabilities as the source of competitive advantage, thus overlooking the fact that inferior capabilities may overshadow the superior ones. By linking the concept of superior and inferior capabilities to specific value activities, we demonstrated how KI-SMMs create and sustain competitive advantage by employing a strategic configuration that allows exploitation of their relatively superior capabilities (in R&D activities) while minimizing disadvantages arising from their relatively inferior capabilities (in production and marketing activities). The empirical findings mostly supported our hypotheses. The KI-SMMs aimed to secure superior and core capabilities in R&D activities through internalization and tended to compensate for their inferior capabilities in production activities, which were viewed as noncore capabilities, through externalization. The main challenge for KI-SMMs was how to handle their marketing activities, which were considered a core capability for these companies, but one for which they had a relatively inferior capacity. We showed that KISMMs tended to resolve this challenge by internalizing marketing activities and by focusing on market niches and/or organizational customers, thereby forgoing the need for an extensive global distribution and servicing infrastructure. When we linked the strategic configuration of KI-SMMs to performance (measured by two profitability ratios), our findings indicated that R&D and marketing expenses were positively correlated to performance, further supporting the above argumentation. Previous studies have often argued that whereas the size and experience of larger firms are expected to enable them to internalize foreign marketing operations (Agarwal and Ramasawi, 1992; Buckley and Casson, 1976), small firms are able to compete globally by exploiting alliances in marketing activities (Bell, 1995; Kaufmann, 1995; Coviello and Munro, 1997). While alliances may provide a good solution to nonknowledge-intensive small- and medium-sized firms, this is not necessarily the case for KI-SMMs. These firms need to internalize marketing activities in order to protect proprietary know-how and secure their customer base. KI-SMMs compensate for their disadvantage in size by trying to minimize the number of transactions they conduct while maximizing the value of each transaction. This is achieved not only by targeting market niches (Gomes-Casseres, 1997; Kohn, 1997), but also by focusing on large, organizational customers.

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Some of the RBV critics argue that it ignores the impact of the external environment on the development of capabilities (Porter, 1996; Teece, 2000). The concept of superior and inferior capabilities, the linkage between the firms capabilities and its internalization/ externalization decisions, as well as the linkage between capabilities and the nature of the firms customers, might all be a first step in better explaining how the firms environment shapes the development of capabilities. Arguably, superior capabilities are created and strengthened through internalization, whereas inferior capabilities are compensated for by externalization or by choosing business models which neutralize the firms disadvantages. The observation that KI-SMMs choose to operate in market niches or to serve organizational customers is important, because it implies that by targeting specific markets in order to compensate for inferior capabilities, KI-SMMs are able to create new capabilities due to first-mover advantages (Acs et al., 1997; Amin and Thrift, 1994; Keeble et al., 1997; McNaughton, 2000). This insight seems to be a promising avenue for future research. When comparing the strategic configuration of KI-SMMs to that of KI-MNCs, several differences emerge. Large KI-MNCs (e.g., Microsoft, Intel, HP, IBM, and Cisco) are expected to create and sustain competitive advantage based on their R&D and marketing activities and to internalize these activities similarly to KI-SMMs. In many cases however, the scope of technologies used by KI-MNCs is wider than that of KISMMs, hence while core technological areas are likely to be internalized, complementary technological capabilities might be accessed through all sort of cooperative ventures. Unlike KI-SMMs, KI-MNCs are able to internalize their production activities as a result of their size. This enables KI-MNCs to better exploit scale and learning economies in production. Moreover, KI-MNCs may use their superior financial and managerial resources and greater experience to develop a wide distribution and services infrastructure in host markets, allowing the targeting of mass-market consumers across countries and continents. Hence, another important avenue for future research is to compare empirically the strategic configuration of KI-SMMs and KI-MNCs and to evaluate the impact of these strategic configurations on the performance of the two groups. There are several limitations to this study. Because this study focused on publicly traded KI-SMMs with a proven business record, the results may be somewhat biased. This bias stems from the fact that only dsuccessfulT firms were studied, while the sample did not include KI-SMMs that failed or remained private. In addition, the study is based on a rather small sample of firms from a single country. Replicating this study employing larger samples of firms from several countries will certainly enhance the external validity of our findings. Third, some of the variables were measured by proxies (e.g., expenses on various activities), while others were based on binary rather than continuous variables (measurement of internalization and the characteristics of the firms markets and customers); refinement of the variables may increase the internal validity of our findings. Although beyond the scope of this study, the fact that KI-SMMs target mainly market niches and organizational customers raises the question of future growth. Will it be possible for KI-SMMs, which employ the suggested strategic configuration, to become large KI-MNCs? If KI-SMMs wish to grow, they need to penetrate a larger variety of

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customers. Because we have argued that constraints of size and experience may inhibit KISMMs from targeting mass consumer markets, it seems that these firms will have to pursue strategic marketing alliances to enable rapid growth. However, strategic alliances may play a contradictory role. While they compensate for the cost and difficulty of creating a distribution and after-sales services infrastructure in host markets, they threaten the ability of KI-SMMs to protect their proprietary technological know-how and their market base. Is this conflict inevitable? Will KI-SMMs need to risk their proprietary knowhow and client base if they wish to grow rapidly? Are there any particular strategic configurations that enable firms to protect their know-how while leveraging on the marketing infrastructures of larger MNCs? These are critical questions that need to be addressed in future studies.

Acknowledgements This study has benefited from the comments of Seev Hirsch, Jonathan Menuhin, Eli Noy, Avraham Meshulach, and three anonymous reviewers for the Journal of International Management. The authors wish to thank the Research Unit of the School of Business Administration, the College of Management, and the Asper Center for Entrepreneurship at the Hebrew University for their financial support. They further wish to thank Susanne Tam and Michiel Dijk for their work on the database.

Appendix A. Details of measure

Variable Performing R&D activities exclusively in-house Performing production activities exclusively in-house Performing marketing activities exclusively in-house Ratio of operating profit to sales Ratio of operating profit to assets Ratio of R&D expenses to sales Ratio of marketing expenses to sales Ratio of cost of goods to sales Firm size Firm age Measure 1Yes 2No 1Yes 2No 1Yes 2No Operating profit/sales Operating profit/(current assets+long-term assets) R&D expenses/sales Marketing expenses/sales Cost of goods/sales Number of employees in 1999 1999 minus year of establishment Notes dNoT includes: alliances or joint ventures in R&D dNoT includes: alliances, outsourcing, or joint ventures in production dNoT includes: alliances, licensing, or joint ventures in marketing Taken from financial reports for 1999 Taken from financial reports for 1999 Taken from financial reports for 1999 Taken from financial reports for 1999 Taken from financial reports for 1999

T. Almor, N. Hashai / Journal of International Management 10 (2004) 479500 Appendix A (continued) Variable Industry Measure Classified into four dummy variables representing whether a firm belongs to one of the following industries: (1) software, (2) information and communication technologies, (3) electronics, and (4) dotherT, which includes pharmaceutics, biotechnology, and medical technologies. Firms were requested to define the location of their R&D activities as follows: 1Israel, 2USA, 3EU, 4South East Asia, 5rest of the world, 6Israel and a foreign region. Firms were requested to define the location of their production activities as follows: 1Israel, 2USA, 3EU, 4South East Asia, 5rest of the world, 6Israel and a foreign region. Firms were requested to define the location of their marketing (including post sales services) activities as follows: 1Israel, 2USA, 3EU, 4South East Asia, 5rest of the world, 6Israel and a foreign region. Firms were requested to indicate whether their market is defined as 1niche market, 2mainstream market, 3both. Firms were asked to identify their customer type as follows: 1OEM customers, 2end customers (private), 3end customers (businesses), 4resellers, 5others. Firms were requested to rank their three most important strategic capabilities, among the following list: innovation, understanding technological needs of clients, time to market, marketing and after sales services, high production quality, low cost resources, and other. Notes

497

Each firm was classified into a single industry

R&D activities exclusively located in Israel

Item 1 was converted into: 1dYesT. Items 26 were translated into: 2dNoT.

Production activities exclusively located in Israel

Item 1 was converted into: 1dYesT. Items 26 were translated into: 2dNoT.

Marketing activities exclusively located in Israel

Item 1 was converted into: 1dYesT. Items 26 were translated into: 2dNoT.

Primarily targeting market niches

Item 1 was converted into: 1 dYesT. Items 2 and 3 were converted into: 2dNoT. Items 1, 3, and 4 were converted into: 1dYesT. Items 2 and 5 were converted into: 2dNoT.

The majority of customers are organizational

Strategic capabilities

A combined grade was calculated where capabilities that were ranked d1T received a score of 3, capabilities that were ranked d2T received a score of 2, and capabilities that were ranked d3T received a score of 1. Summation of the overall ranking of each strategic capability yielded a quantitative proxy of the evaluation of each capability by the firms.

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Appendix B. Correlation matrix

Variable Ratio of R&D to sales Ratio of marketing to sales Ratio of COG to sales nNumber of observations. * Significant at pb0.1. ** Significant at pb0.01. Ratio of R&D to sales 1 Ratio of marketing to sales 0.662** n=36 1 Ratio of COG to sales 0.533* n=51 0.500* n=36 1

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